Research Database

This paper investigates why high income households in the United States save on average more than low income households in cross-section data. The three explanations considered are (1) age differences across households, (2) temporary earnings shocks, and (3) the structure of transfer payments. We use a calibrated life-cycle model to evaluate the quantitative importance of these explanations and find that age and the structure of transfers are quantitatively important in producing the cross-section pattern of United States savings rates. Temporary shocks are of secondary importance.

In this paper we examine the role of social security in an economy populated by overlapping generations of individuals with time-inconsistent preferences who face mortality risk, individual income risk, and borrowing constraints. Agents in this economy are heterogeneous with respect to age, employment status, retirement status, hours worked, and asset holdings. We consider two cases of time-inconsistent preferences. First, we model agents as quasi-hyperbolic discounters. They can be sophisticated and play a symmetric Nash game against their future selves; or they can be naive and believe that their future selves will exponentially discount. Second, we consider retrospective time inconsistency. We find that (1) there are substantial welfare costs to quasi-hyperbolic discounters of their time-inconsistent behavior, (2) social security is a poor substitute for a perfect commitment technology in maintaining old-age consumption, (3) there is little scope for social security in a world of quasi-hyperbolic discounters (with a short-term discount rate up to 15%), and, (4) the ex ante annual discount rate must be at least 10% greater than seems warranted ex post in order for a majority of individuals with retrospective time inconsistency to prefer a social security tax rate of 10% to no social security. Our findings question the effectiveness of unfunded social security in correcting for the undersaving resulting from time-inconsistent preferences.

Can neoclassical theory account for the Great Depression in the United States—both the downturn in output between 1929 and 1933 and the recovery between 1934 and 1939? Yes and no. Given the large real and monetary shocks to the U.S. economy during 1929–33, neoclassical theory does predict a long, deep downturn. However, theory predicts a much different recovery from this downturn than actually occurred. Given the period’s sharp increases in total factor productivity and the money supply and the elimination of deflation and bank failures, theory predicts an extremely rapid recovery that returns output to trend around 1936. In sharp contrast, real output remained between 25 and 30 percent below trend through the late 1930s. We conclude that a new shock is needed to account for the Depression’s weak recovery. A likely culprit is New Deal policies toward monopoly and the distribution of income.

There is widespread agreement that a surprise increase in an economy's money supply drives the nominal interest rate down and economic activity up, at least in the short run. This is understood as reflecting the dominance of the liquidity effect of a money shock over an opposing force, the anticipated inflation effect. This paper illustrates why standard general equilibrium models have trouble replicating the dominant liquidity effect. It also studies several factors which have the potential to improve the performance of these models.

Stochastic inflation affects the risk characteristics, measured by the equity premium and the correlation of the equity’s return with consumption, in a fundamental way. The riskiness of a dollar-denominated asset depends on two conditional covariances: the covariance of the marginal rate of substitution (MRS) with the equity price and the covariance of the MRS with the rate of appreciation in the purchasing power of money. The second covariance may take either sign which becomes significant when the risk characteristics of the dollar-denominated asset are compared with the risk characteristics of an indexed asset constructed in a real version of the model.

The effects of stochastic inflation on the assets’ risk characteristics are studied in a parameterized version of a cash-in-advance asset-pricing model. The growth rates of the endowment and monetary transfer evolve according to a VAR. The equity price is a geometric distributed lead of log–normally distributed random variables; an algorithm to express the price as an explicit function of the state variables is described.

Barksy-Miron [1989] find that the postwar U.S. economy exhibits a regular seasonal cycle, as well as the business cycle phenomenon. Are these findings consistent with current equilibrium business cycle theories as surveyed by Prescott [1986]? We consider a dynamic, stochastic equilibrium business cycle model which includes deterministic seasonals and nontime-separable preferences. We show how to compute a perfect foresight seasonal equilibrium path for this economy. An approximation to the stochastic equilibrium is calculated. Using postwar U.S. data, GMM estimates of the structural parameters are employed in the perfect foresight and simulation analyses. As in Constantinides and Ferson [1990], the estimates of consumption preferences exhibit habit-persistence, but a local optimum also exists which exhibits local durability.

The nontime-separable model predicts most of the seasonal patterns found in aggregate quantity time series; notable exceptions are the seasonal patterns in investment and the fourth quarter seasonal in labor hours. An evaluation of the model’s predictions for deseasonalized second moments finds strong support for the parameterization with local durability in consumption. This model broadly displays a seasonal cycle as well as the business cycle phenomenon.

This paper uses micro data to examine differences in the cyclical variability of employment, hours, and wages for skilled and unskilled workers. Contrary to conventional wisdom, we find that, at the aggregate level, skilled and unskilled workers are subject to essentially the same degree of cyclical variation in wages. That is, relative offer wage differentials between skilled and unskilled workers are acyclical. However, we do find important differences in the patterns of employment and hours variation for skilled vs. unskilled workers when a college degree is used as a proxy for skill. Workers with a college degree have little cyclical variation in employment or weekly hours, while uneducated workers have highly procyclical employment and hours. Thus, we find that the quality of labor input per manhour rises in recessions, thereby inducing a countercyclical bias in aggregate wage measures. We find substantial differences across industries in the cyclical variation of employment, hours, and wage differentials. We interpret these results as indicative of important inter-industry differences in labor contracting.

This study demonstrates that the U.S. equity premium has declined significantly during the last three decades. The study calculates the equity premium using a variation of a formula in the classic Gordon stock valuation model. The calculation includes the bond yield, the stock dividend yield, and the expected dividend growth rate, which in this formulation can change over time. The study calculates the premium for several measures of the aggregate U.S. stock portfolio and several assumptions about bond yields and stock dividends and gets basically the same result. The premium averaged about 7 percentage points during 1926–70 and only about 0.7 of a percentage point after that. This result is shown to be reasonable by demonstrating the roughly equal returns that investments in stocks and consol bonds of the same duration would have earned between 1982 and 1999, years when the equity premium is estimated to have been zero.

This paper documents several advantages associated with using state level consumption data to examine consumption behavior and especially to estimate the Intertemporal Elasticity of Substitution (IES). In contrast to the results of Hall (1988) and Campbell and Mankiw (1989), we provide substantial evidence indicating that the IES is significantly different from zero and probably close to one. Since the overidentifying restrictions of the standard Euler equation are generally rejected, we use these data to explore the nature of these rejections and evaluate an alternative specification of consumer behavior proposed by Campbell and Mankiw (1987, 1989, 1990). We take special care of examining the robustness of our results with respect to problems caused by the mismeasurement of the interest rate. In particular, we identify a common time component in expected consumption growth across states which, under the specifications of the theory, should reflect real interest rate movements. We find that the common time component closely matches the expected real return on Treasury bills as should be expected if the IES is different from zero and if the T-bill rate is an appropriate measure of interest rates.

This article reexamines the conventional wisdom that commercial banking is in severe decline. A careful reading of the evidence does not support it. True, on-balance sheet assets held by commercial banks have declined as a share of total intermediary assets. But this measure ignores the substantial growth in banks' off-balance sheet activities, in off-shore lending by foreign banks, and in the size of the financial intermediation sector. Adjusted for these considerations, the bank-assets measure shows no clear evidence of secular decline. Neither does an alternative measure, constructed using data from the national income accounts. At most, banking may have suffered a slight loss of market share lately. But this loss is a temporary response to a series of adverse shocks rather than the start of a permanent decline.

In this paper we use the common perspective provided by the neoclassical growth model to evaluate the size of the distortions associated with different monetary and fiscal policies designed to finance a given sequence of government expenditures. We construct an artificial monetary economy incorporating the cash-in-advance framework of Lucas and Stokey (1983), calibrate it to match important features of the U.S. economy, and simulate it to provide a quantitative assessment of the welfare costs associated with government policies involving different combinations of taxes on capital and labor income, consumption, and holdings of money. In particular, we evaluate the welfare gains from tax reforms that are designed to replace taxes on capital or labor income with other forms of taxation. Our results suggest that the welfare costs of financing a given sequence of government expenditures are slightly lower in economies that substitute inflation or consumption taxes for the tax on labor income, but dramatically lower for economies that substitute any of these taxes for the tax on capital income. Replacing the capital tax with a consumption tax, for example, eliminates 81 percent of the welfare cost arising from distorting taxation. In addition, we show that these welfare costs can be reduced further by eliminating the capital tax with a nonstationary policy that involves a transition to a temporary policy followed by a new steady state policy rather than an immediate change to a new steady state policy.

A classic example of a privately created interbank payments system was operated by the Suffolk Bank of New England (1825–58). Known as the Suffolk Banking System, it was the nation’s first regionwide net-clearing system for bank notes. While it operated, notes of all New England banks circulated at par throughout the region. Some have concluded from this experience that unfettered competition in the provision of payments services can produce an efficient payments system. But another look at the history of the Suffolk Banking System questions this conclusion. The Suffolk Bank earned extraordinary profits, and note-clearing may have been a natural monopoly. There is no consensus in the literature about whether unfettered operation of markets with natural monopolies produces an efficient allocation of resources.

This study was originally published in the St. Louis Federal Reserve Bank’s Review (May/June 1998, vol. 80, no. 3, pp. 105–16).

This article investigates the business cycle implications of the planning phase of business investment projects. Time to plan is built into a Kydland-Prescott time-to-build model, which assumes that investment projects take four periods to complete. In the Kydland-Prescott time-to-build model, resources for these projects flow uniformly across the four periods; in the time-to-plan model, few resources are used in the first period. The investigation determines that incorporating time to plan in this way improves the model's ability to account for three key features of U.S. business cycles: their persistence, or the fact that when output growth is above (or below) average, it tends to remain high (or low) for a few quarters; the fact that productivity leads hours worked over the business cycle; and the fact that business investment in structures and business investment in equipment lag output over the cycle.